Should You Use M.J. International's (TPE:8466) Statutory Earnings To Analyse It?

It might be old fashioned, but we really like to invest in companies that make a profit, each and every year. Having said that, sometimes statutory profit levels are not a good guide to ongoing profitability, because some short term one-off factor has impacted profit levels. In this article, we'll look at how useful this year's statutory profit is, when analysing M.J. International (TPE:8466).

It's good to see that over the last twelve months M.J. International made a profit of NT$345.4m on revenue of NT$3.02b. Below, you can see that both its revenue and its profit have fallen over the last three years.

Check out our latest analysis for M.J. International

Importantly, statutory profits are not always the best tool for understanding a company's true earnings power, so it's well worth examining profits in a little more detail. So today we'll look at what M.J. International's cashflow tells us about the quality of its earnings. Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of M.J. International.

Examining Cashflow Against M.J. International's Earnings

As finance nerds would already know, the accrual ratio from cashflow is a key measure for assessing how well a company's free cash flow (FCF) matches its profit. To get the accrual ratio we first subtract FCF from profit for a period, and then divide that number by the average operating assets for the period. This ratio tells us how much of a company's profit is not backed by free cashflow.

Therefore, it's actually considered a good thing when a company has a negative accrual ratio, but a bad thing if its accrual ratio is positive. While it's not a problem to have a positive accrual ratio, indicating a certain level of non-cash profits, a high accrual ratio is arguably a bad thing, because it indicates paper profits are not matched by cash flow. To quote a 2014 paper by Lewellen and Resutek, "firms with higher accruals tend to be less profitable in the future".

For the year to September 2020, M.J. International had an accrual ratio of 0.27. Unfortunately, that means its free cash flow fell significantly short of its reported profits. In the last twelve months it actually had negative free cash flow, with an outflow of NT$306m despite its profit of NT$345.4m, mentioned above. We saw that FCF was NT$169m a year ago though, so M.J. International has at least been able to generate positive FCF in the past.

Our Take On M.J. International's Profit Performance

M.J. International's accrual ratio for the last twelve months signifies cash conversion is less than ideal, which is a negative when it comes to our view of its earnings. Therefore, it seems possible to us that M.J. International's true underlying earnings power is actually less than its statutory profit. Sadly, its EPS was down over the last twelve months. Of course, we've only just scratched the surface when it comes to analysing its earnings; one could also consider margins, forecast growth, and return on investment, among other factors. With this in mind, we wouldn't consider investing in a stock unless we had a thorough understanding of the risks. When we did our research, we found 4 warning signs for M.J. International (2 are concerning!) that we believe deserve your full attention.

Today we've zoomed in on a single data point to better understand the nature of M.J. International's profit. But there are plenty of other ways to inform your opinion of a company. Some people consider a high return on equity to be a good sign of a quality business. While it might take a little research on your behalf, you may find this free collection of companies boasting high return on equity, or this list of stocks that insiders are buying to be useful.

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This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
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